PCTEL, Inc.
Q4 2016 Earnings Call Transcript

Published: 8 Mar 2017

[Operator:]

Welcome to the PCTEL Fourth Quarter Earnings Release conference Call. At this time, all participants are in a listen-only mode. At the conclusion of the prepared remarks, we will conduct a question-and-answer session. As a reminder, this conference call is being recorded. I will now turn the call over to John Schoen, the Company's CFO.

[John Schoen:]

Thank you for joining us on today's conference call to discuss PCTEL's Fourth Quarter 2016 Financial Results. With me today is, David Neumann, the company's new CEO. Before we begin, let me remind you that this call may contain forward-looking statements. While these forward-looking statements reflect PCTEL's best current judgment, they are subject to risks and uncertainties that could cause actual results to materially differ from those forward-looking projections. Risks factors that could cause PCTEL's actual results to materially differ from its projections are discussed in the earnings release which was issued today. It is also available on our website in our most recent 10-K. Additionally, our commentary will include reference to non-GAAP measures. They are non-GAAP earnings per share, adjusted EBITDA and free cash flow. We believe these non-GAAP measures facilitate comparability results over different periods. A full reconciliation of these non-GAAP measures to our GAAP basis measures is included in our quarter earnings press release that was issued earlier today. With that, it's now my pleasure to turn the call over to David Neumann.

[David Neumann:]

Good morning. Thank you for joining our call today. Although I've been at PCTEL for eight years and have participated in past earnings calls, this is my first as CEO. I'm looking forward to working closer with the investment community in this role. We finished strong in 2016 and we are maintaining momentum in Q1 2017. Fourth quarter 2016 revenue gross profit, adjusted EBITDA, non-GAAP profit and free cash flow all improved when compared both sequentially and over the same period last year. The first quarter 2017 financial guidance we will be providing later on this call is a significant improvement over the results of the same period last year. In short, we're encouraged by the direction the company is headed. We just returned from Mobile World Congress in Barcelona and it confirms our belief that small cells, 5G and ultimately the internet of things will drive growth at PCTEL. Data demands and cell capacity limitations require smaller cells and denser configurations. Small cell shipments are forecasted to more than double by 2020 to more than 10 million units. This growth will be exacerbated further as 5G rolls out because the higher frequencies travel even shorter distances than the current and pre-seating technologies. It might take 10 times the number of today's base stations to deploy mobile 5G service throughout an existing 4G footprint. Small cell growth in 5G will drive the demand for antennas, test and measurement tools and engineering services. Small cell roll outs benefit both our businesses. In Connected Solutions, we're delivering a significant quantity of small cell antennas to one of our key OEMs in China and we expect this business to remain strong. We continue to make significant investments in R&D and operations in China to support this business. We're confident that our four areas of focus for antennas, small cells, enterprise Wi-Fi, fleet and utilities will drive growth for PCTEL. In our solutions, we continue to build applications to leverage the install base of the IBflex to address small cell and in-building applications. Our latest tablet-based SeeHawk Touch solution includes specific features to test and commission small cell deployments. I would like to note that John and I will be attending the East Coast Ideas Investor Conference on May 17 and 18 in Boston and we will present at the 18th Annual B. Riley Investor Conference held on May 24 and 25 in Santa Monica. We look forward to meeting with investors at these shows. With that, I will now turn the call over to John Schoen for a closer look at our fourth quarter financial results and first quarter 2017 guidance.

[John Schoen:]

Thanks, David. First, let me start with a recap of the full year with comparisons to 2015. Our top line revenue was challenged in the first three quarters of 2016 with annual revenue declining $10 million to $96.7 million. The first three quarters were impacted by several large multi-year projects coming to an end, as well as our decision at the end of 2015 to prune low margin businesses obtained through earlier acquisitions. On lower annual revenue, we reported 150 basis point improvements in our gross profit, a $1.6 million improvement in adjusted EBITDA or 30% higher, $0.20 per share of non-GAAP EPS, up 82% and free cash flow of $8.5 million at 8.8% of revenue compared to $7 million and 6.6% of revenue last year. We believe that the improved profit and cash flow profile validate our decision to prune lower margin product lines that were not core to our future growth. Now I would like to address the fourth quarter 2016 and compare results to the same period last year. Revenue was $26.7 million, up 2%. Gross profit was 37.4%, up 190 basis points. Adjusted EBITDA was $2.3 million, up 53% and non-GAAP earnings per share were $0.08 a share, up 100%. Drilling down, Connected Solutions revenue was $18.1 million, up 9% with gross profit of 31.3%. That's up 230 basis points over the same period last year. Small cell antenna growth was a key contributor to revenue and the exit of lower margin product lines and other cost reduction actions taken in late 2015 improved gross profit. RF solutions revenue was $8.6 million, down 10%, but gross profit was 50 points, up 340 basis points. A decline in service revenue with its lower gross profit compared to products accounts for the increased average gross profit percent. Now let's turn to guidance for the first quarter of 2017. We thought we would make it easier for shareholders to digest the company's guidance. Going forward, we will be giving guidance for the next quarter for revenue, non-GAAP gross profit and non-GAAP EPS. First quarter revenue is expected to be between $24 million and $24.5 million. Gross profit is expected to be between 37% and 38% and non-GAAP earnings per share are expected to be between $0.03 and $0.04 per share at that revenue range. This compares to first quarter 2016 revenue of $21.1 million in a non-GAAP net loss of $0.03 a share. Before we take questions, I would like to turn the call over to David to make a few closing remarks.

[David Neumann:]

Thanks, John. To summarize, we are pleased with our Q4 results and momentum we're building early in 2017. Both of PCTEL's businesses Connected Solutions and RF Solutions are in strong position to benefit from small cell deployments, 5G and IoT. And we will continue to make investments in R&D, staff and capital to create and maintain our competitive advantage. With that, John and I would like to open up the call for questions. Operator?

[Operator:]

[Operator Instructions] Your first question comes from the line of Matt Robinson with Wunderlich. Your line is open.

[Matthew Robinson:]

Hey, thanks and congratulations on the results. A couple of housekeeping items, and then David, maybe you could talk a little bit about the customer concentration you may have in small cells and how you expect that to change. John, first up, can you give us operating cash flow depreciation and CapEx and maybe give a real comment on what you think you can do in terms of growing free cash flow from here? That $8.5 million, looks like it's going to be a pretty tough comparison.

[David Neumann:]

Yes. First with the housekeeping matters. Depreciation was $745,000 in the quarter, CapEx was $213,000, operating cash flow was $32.49 [ph].

[Matthew Robinson:]

Okay.

[David Neumann:]

Okay. And then as far as with cash flow comparisons, one of the contributions to cash flow was this year it was a concerted effort to get a lot more efficient on inventory turns. There are still a couple of million dollars more to go in 2017. I do agree with you if $8.5 million is going to be a challenging comparable, but we're actually thinking we're going to be somewhere in the $8 million to $9 million because we still got a couple of million more to get out of inventory if we can execute, but that's going to be the key to make in that number.

[Matthew Robinson:]

Okay. David, can you maybe give us a little bit of a perspective on the customers driving your business right now and what your prospects are for scaling into other customers and perhaps direct us with network operators?

[David Neumann:]

Well, you mentioned first, Matt, customers regarding small cells?

[Matthew Robinson:]

Yes.

[David Neumann:]

Well, small cells, specifically, they're really three vendors. So you've got Huawei, Nokia and Ericsson. They account for about 70% of the market. We're delivering small cell antennas to two of the three, so we're I think, in a very good position regarding small cells and going forward at any given time, there's five to seven small cell projects in design. So I think we have some growth opportunities as these small cells rule out as well.

[Matthew Robinson:]

It's an OEM kind of a business as opposed to something you can move into serving carriers directly? Is that it?

[David Neumann:]

That's correct. In fact when you see the antennas deployed, you're not going to see a PCTEL logo on the antenna. We're manufacturing those for the OEMs.

[Matthew Robinson:]

Is it in this nature that's integrated so much that it's just impractical to...

[John Schoen:]

Right. And just a reminder, Matt, remember our business model in antennas where our customer capture is done to the engineering department. It's not only the design of the antenna, but its interference mitigation -- RF interference and mitigation there. So our antennas, at least in the small cell space are designed specifically for each of these customers.

[Matthew Robinson:]

It kind of brings to mind a notion of barriers because these companies, one is in China by headquarters. The other does most of the design for this sort of thing and China are a lot of it, I believe. How do you protect that business? Is it at the engineering level?

[David Neumann:]

It's been actually the supplies for both Connected Solutions and RFS. At our core, we're an engineering company and we're successful when we solve difficult RF problems. So we spend quite a bit of effort and investment in engineering in both Connected Solutions for the design of new antennas in RFS as well. A scanning receiver might take two to three years to develop before it goes into the market, but once it's in the market and we have that as a barriered entry [ph] the competition -- we typically have a longer runway for sales. If you look at the IBflex, we launched that I think in 2014 and it's still probably one of the most popular scanning receivers in the market.

[Matthew Robinson:]

I've got one more question and then I'll let somebody else go. It's my impression that you had a bit of an [indiscernible] for distributor antenna systems with business from the facility providers as opposed to a carrier so much for that type of product back in a couple of years ago. And now, we're moving towards small cells for capacity, it seems. Are you going to pursue network engineering systems type of business for small cell, or is it the supply chain sufficiently different that it's not so lucrative in that regard?

[David Neumann:]

A small cell deployment at the end venues?

[Matthew Robinson:]

Well, you had real estate owners, other venues like schools and so forth deploying the distributor antenna systems along with your help from any asset, I believe in the past and that's way end of it in small cells in the different supply chain more with the equipment suppliers, with system suppliers to the operators. Am I right about that?

[David Neumann:]

I think small cells will -- there will always be a place for DAS, but small cells will take a bigger portion at market, but from our perspective. It doesn't really matter. Specially for engineering services and we're doing planning irregardless of what the hardware is. We're working with different OEMs, OEMs for DAS and small cell. The tools that we develop apply both for planning optimization of DAS and small cell. I think we're in a good position as the market moves to small cells, but I don't think that the business model changes too much for us.

[John Schoen:]

The OEM model is going to dominate our growth. It's the only place you can get seven figures apart numbers.

[David Neumann:]

[Indiscernible].

[Matthew Robinson:]

I guess the bottom line is we could see another wave of demand, but we're not going to try to participate so much by adding a bunch of headcount in order to provide services.

[David Neumann:]

That's correct. It would be the same step. Operator?

[Operator:]

[Operator Instructions] Your next question comes from the line of Mike Crawford with B. Riley and Company. Your line is open.

[Michael Crawford:]

Thank you. Further regarding small cells; I think for most consumers, like having a 5G service is something that's probably still several years out. So how does that network deployment around the globe effect PCTEL selling to carriers that are testing these things and starting to build them out from what has been a non-existent network to this point.

[David Neumann:]

Well, small cells aren't just for 5G. Small cells are being deployed today for 4G. It's not necessarily the change in technology that's going to drive the growth, it's the increased demand for capacity and as capacity increases, cells can only handle so many users so you need to put in more cells, the cells get denser, enhance the benefits of having a small cell network. As far as 5G, you're right, Mike, it's several years off. I think the standard is planned to be completed by 2020. But keep in mind that the operators are releasing pre-5G technologies now which are in the higher frequency millimeter wavelength bands, so there will be a migration to 5G and through that migration, especially for the test of measurement equipment, the operators are going to need tools to support the higher frequencies and also the new access technologies. I do see some opportunities with testing measurement where probably -- and I would call a 'maintenance mode' now where there's not a lot of growth, but once you get to early 2018, early 2019, I think we'll see a pick up there. And the antenna business, especially around small cells is going to be driven by capacity and end users. There will be some benefits with 5G, but we're not waiting for 5G to sell and grow the antenna business.

[Michael Crawford:]

Okay, thank you. And who would you say has the biggest share of antennas for small cell applications and where do you sit in that hierarchy?

[David Neumann:]

Amphenol is one of our larger competitors. Depending on the market and the customer, we're one or two.

[Michael Crawford:]

Okay, great. Thanks. And then on the test side, I think you had some perhaps unexpected strength or welcome strength and scan receivers in Q4. Is there anything in particular that drove that versus what had been the softer business for you in 2016?

[David Neumann:]

There is somewhat of a cycle with the test to measure equipment and Q4 is typically a bit stronger and that's really driven by budgets, end of your budget is going away, customers need to spend the money or lose it. It was a good quarter and the momentum, we've maintained it in the Q1. So it's encouraging.

[Michael Crawford:]

And with your engineering services work, it's a business that's been a little like your terms, but I believe helps you to stay engaged with potential customers and drive other test sales. But is there any particular change you're making to that organization?

[David Neumann:]

We're not making any changes and I think you're right. It doesn't throw off as much cash as the tools, but it's a great feedback loop to have engineers in the field to bring back ideas for products and applications. In fact a couple of the products that we're selling to the market came directly from the NES Group. It's also a great way to support the PCTEL brand both for the tools and for the antennas.

[Michael Crawford:]

Okay, thanks. And then final question, just relates back to the fleet market which is one of your focus areas for antennas, but what dynamics are you see driving that business?

[John Schoen:]

Continues to be strong. I think it's not short term, but it's work around autonomous vehicles that you're going to need more antennas to communicate back to the infrastructure and vehicle to vehicle. As you know, we're very strong in the GNSS base and we hope to use that to leverage to get more into the autonomous vehicles space.

[Michael Crawford:]

Great, thank you.

[Operator:]

There are no further questions at this time and the call will now end. You may disconnect.